Financial contagion: problems of proximity and connectivity in financial markets

Abstract

ABSTRACT Financial contagion is often defined as the propagation of shocks among actors in markets, while excessive correlation and interconnectivity of markets, actors or investment strategies are seen as reasons for its spread. In this article, I examine uses of the concept of contagion across academic, practical and popular discourses on financial markets and speculation from the late nineteenth century through the first couple of decades of the twentieth: During this historical period the concept was frequently used about forms of allegedly irrational behaviour in financial markets. I argue that ‘contagion’ is used descriptively to capture behaviour and events that escape rational economic explanation and, more importantly, highlights problems of proximity and connectivity in financial markets. While the proximity and connectivity of actors enables market efficiency, they simultaneously increase the risk of contagion. In the latter part of the article, I use a contemporary example of liquidity contagion in model-driven financial investing – the so-called Quant Meltdown of August 2007 – to emphasise that problems of proximity and connectivity, described as instances of contagion, remain pertinent challenges for market actors to deal with.